The tea-leaf readers are at it again and the administration’s pressure for lower interest rates continues to be intense. This week, Bloomberg reports that government bonds in Denmark, Germany, Japan, Sweden, and Switzerland carry negative yields — meaning it will cost money for investors to hold them to maturity. Thus, a “big question for fixed-income markets in 2020 is whether it could happen in the U.S., too.”
Bond yields fall when their prices rise, and in August investors piled heavily into U.S. Treasuries, driving yields on the benchmark 10-year bond to a three-year low of 1.43% by early September. Yields have climbed back some since that time, to around 1.8%, but investors are still getting a razor-thin income for lending to the U.S. government.
There are several reasons why that matters, the report says. First, the yields on these bonds help set the pace for long-term borrowing costs throughout the economy — but they also reflect investors’ sentiments about the economy. “And the story these low yields tell isn’t rosy,” Bloomberg says.
One force pulling down bond yields has been the U.S. Federal Reserve’s recent cuts in key short-term interest rates that are added to stimulate the U.S. economy — in part because it’s worried about a slowdown in global growth. Meanwhile, the fact that 10-year bond investors are willing to be paid so little suggests they have little fear of inflation, which usually goes hand in hand with a strong expansion.
If the Fed keeps cutting short-term rates back to near zero, where they were from late 2008 to 2015, and also restarts quantitative easing, “negative yields on U.S. Treasuries could swiftly change from theory to reality,” Joachim Fels, global economic adviser at Pacific Investment Management Co., said.
Still, that scenario is an “outside shot,” Bloomberg says. Futures markets are anticipating more Fed rate-cutting, perhaps as soon as late October. But zero is several normal-size cuts of 0.25% away.
Even more than usual, the direction of rates may depend on global politics. Bruno Braizinha, U.S. rates strategist for Bank of America Corp., says he sees “meaningful” risks to the economic outlook and even a chance that the 10-year yield may hover near zero by the end of 2020—but that a signed U.S.-China trade deal could go a long way toward halting that momentum.
However, JPMorgan Chase & Co. strategist Jan Loeys foresees the possibility of the benchmark yield reaching zero by 2021, a full year quicker than he previously thought, citing trade tensions and worries about capital spending.
Others think a big drop in yields from here may be hard to get. Margaret Steinbach, a fixed-income investment specialist at Capital Group, says, “Global investors are trying to figure out if we are in a midcycle slowdown heading into next year or the beginning of a more protracted downturn.
In addition to borrowers, one more group should be paying attention to yields: investors in fixed-income funds. Since the drop in yields has gone along with rising values for existing bonds, many funds have recently enjoyed strong returns and that would continue if the march toward zero resumes. If the economy finds its footing and yields stabilize—or rise—gains like that will be a thing of the past.
Still, consumers appear to be buoying up the economy — and are accounting for almost 70% of the U.S. economy — higher than in almost every other country. And while the propensity of Americans to shop has long been crucial for economic growth, it’s particularly the case now.
That’s because companies have pulled back, hiring at a slower pace and postponing long-term investments, and business spending declined earlier this year for the first time since 2016. Manufacturing, which was booming two years ago, is constrained after contracting earlier this year. A good deal of the blame appears to fall on the Trump administration’s trade wars, which have increased costs and created uncertainty for businesses. Also, a “strong” dollar hasn’t helped.
Despite all that, the overwhelming majority of economists, including Bloomberg’s, aren’t predicting a recession in the next 12 months. They are counting on Americans to keep spending—as in 2015 and 2016 when they powered the economy through weakness in the energy and manufacturing sectors.
Continued strong household consumption reflects a simple reality, according to James Sweeney, chief economist at Credit Suisse Group AG. “Households are employed, and their incomes are growing,” he says. And inflation isn’t eating away at those gains and consumer confidence is near historic highs.
Still, some analysts are emphasizing the economic “cracks,” Bloomberg notes and emphasizes that “more people are hunting for bargains now, which could foreshadow a pullback. There’s weakness across some discretionary sectors and prices in once-hot markets such as Los Angeles and New York are stagnant or in decline.
Americans also have loaded up on credit card debt. “It’s just a matter of time until it catches up with people,” says Shah, who reckons that some 40% are on the edge of having to cut back on spending.
So, we will see. The current outlook is increasingly complex, with many, many moving parts and an unusually complicated array of stake holders. Thus, although the situation remains extremely difficult, it is one producers should watch closely as these trends emerge, Washington Insider believes.
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